In a research note published on Thursday, Subramanian calculates that in purchasing power parity (PPP) terms – that is, adjusting for the different costs of living in the two countries – the size of China’s economy was $14.8 trillion in 2010, compared to the US economy’s $14.6 trillion. The IMF’s latest World Economic Outlook, China’s 2010 GDP was only $10.1tn in PPP terms.

What explains the huge discrepancy between these estimates? Subramanian believes that IMF calculations overstate prices in China by focusing solely on urban areas. This has the effect of lowering GDP on a PPP basis. If prices are adjusted downwards to a more accurate level Chinese GDP rises significantly.

Higher PPP estimates would lead to a higher estimate of the undervaluation of the Chinese renminbi against the dollar.

China’s PPP-GDP was underestimated (by the ICP project and by the World Bank) because of the urban bias of the price sampling in ICP 2005. Data on prices were collected for 11 cities and their surroundings but no rural prices—which are typically substantially below urban prices—were collected (or rather allowed to be collected by the Chinese authorities).

The latest version of the Penn World Tables (version 7 to be released in early February 2011) have corrected these biases, which result in an upward revision for China’s PPP-based GDP by about 27 percent and for India by about 13 percent for the year 2005. I use the new PWT corrections as the starting point for computing new estimates for PPP-based GDP and GDP per capita.

A second correction relates to developments between 2005 and 2010. For this period, if the IMF data are taken at face value, they suggest an increase in the real cost of living in China relative to that in the United States (which is equivalent to a real appreciation of the Chinese currency) of about 35 percent. This seems implausible because three alternative ways of assessing currency changes point to a much smaller appreciation.

First, most real exchange rate indices computed for China (for example those of JPMorgan and the Bank for International Settlements) point to an appreciation during this period of between 12 and 20 percent. Analysis of productivity differentials between China and its trading partners, and between tradable and nontradable sectors within China, by the IMF in its 2010 Article IV consultation (p. 19) would also imply an appreciation of the yuan of no more than 10 to 15 percent. Third, one could ask what currency appreciation would be implied for China if it behaved like the average country: For this country, estimates suggest that currency appreciation responds to the difference between its own growth rate of per capita GDP and that of the United States (in the jargon, this is called the dynamic Balassa-Samuelson effect). This procedure also yields estimates of about 10-15 percent for Chinese currency appreciation.

If a currency appreciates, the movement is akin to an increase in the average cost of living. So taking 15 percent as the best estimate of the currency appreciation, rather than the 35 percent estimated by the IMF, requires adjusting China’s 2010 GDP upward by 20 percent (because the increase in the cost of living has been overstated by 20 percent). To be conservative, I have not adjusted GDP up by the entire 20 percent.

These two adjustments increase China’s GDP from the current estimate of $10.1 trillion to $14.8 trillion (an increase of 47 percent, of which 27 percent is due to the revision in the 2005 estimate, and the rest due to smaller-than-assumed increases in the cost of living between 2005 and 2010). This $14.8 trillion figure exceeds US GDP of $14.6 trillion. It must be emphasized, of course, that the difference is small enough to be within the margin of error.

Applying the same adjustments to GDP per capita increases the estimate for China from $7,518 (the current estimate in the IMF’s World Economic Outlook) to $11,047.

Rather than confronting China and risking conflict, the United States and outsiders should nudge China along the path away from mercantilism that it seems to have embarked upon.

The problem, of course, is that the clamorous present and unhelpful Chinese actions on a whole swath of economic and political issues—natural resources, technology, energy, Tibet—demand a vigorous response from the world. The reality is that outsiders have limited recourse. A less lofty reason to embrace the long view is then simply to make virtue out of the cold necessity that the United States and others (including India) may no longer have effective means to force cooperation from a dominant China.

The World Bank defines a person as poor if she consumes, on average, less than $1.08 per day in 1993 prices. This level of consumption is a bare minimum level, a level consistent with bare survival. But according to the [2005 World Bank PPP] data, all of Asia had an average level of consumption of only 0.71 1993 PPP$ per day. In contrast, the estimate for sub-Saharan Africa is $2.07, and that for Latin America, $2.32. But maybe only some people were very poor in Asia. Not so. The average consumption of the bottom 80 per cent of the Asian population was 0.49, or less than half the absolute minimum poverty line. Are these numbers plausible? If yes, then you must not be reading it on planet Earth, because your grandparents did not survive the World Bank induced crash of 2005.